Focus
Considers both long-run and short-run implications of fiscal and monetary policy decisions
- what difference does it make if we stimulate or restrain the economy with fiscal or monetary policy?
Is the Fed Government Budget Deficit Too Large?
Budget Deficit Grows Because:
1) weak economy -> reduced taxes
2) extraordinary spending to fight the financial crisis and recession
- dissatisfaction with massive budget deficit became a major issue
- is it important to shrink the budget deficit quickly
Should the Budget Always Be Balanced in the Short Run?
- constitutional amendment to require a balanced budget has been proposed and debated many times
- instruct makers of fiscal policy to focus on balancing aggregate supply and aggregate demand
*budget deficits = when private demand (C+I+G+(X-IM) is weak
*b
Importance of the Policy Mix
*the appropriate fiscal policy depends on the current stance of monetary policy. Although a balanced budget may be appropriate under one monetary policy, a deficit or a surplus may be appropriate under another
Change in Monetary Policy Will Alter the Appr
Two Consequences of When Changes in Fiscal Policy Affect Interest Rates
1) The Multiplier Formula Revisited
- expansionary fiscal policy raises interest rates, which deters private investment spending -> when government raises G in (C+I+G+(X-IM), one side will probably be a reduction in the I component
- because a rise in G (
Deficits and Debt: Terminology and Facts
- Budget Deficit = is the amount which the government's expenditures exceed its receipts
ex: during fiscal year 2010, the federal government raised almost $2.2 trillion in revenue and spend almost $3.5 trillion resulting in a large deficit of $1.3 trillio
Budget Deficit
is the amount by which the government's expenditures exceed its receipts during a specified period of time, usually a year.
Budget Surplus
is the amount by which the government's receipts exceed expenditures
National Debt (public debt)
is the federal government's total indebtedness at a moment in time. It is the result of previous budget deficits
Facts About National Debt
*public debt is enormous (fiscal year 2010:$43,000/person)
- one-third of the debt was held by agencies of the U.S. government (one branch of the government owed it to another) -> if we deduct this portion, the net national debt was $29,000 per person
*co
Interpreting the Budget Deficit or Surplus
government managed to turn the budget to surplus during the years 1998-2001, but then large deficits reemerged after the Bush tax cuts
The Structural Deficit or Surplus
- same fiscal program can lead to a deficit or a surplus, depending on the state of th
Structural Budget Deficit or Surplus
is the hypothetical deficit or surplus we would have under current fiscal policies if the economy were operating near full employment
- replaces both spending and taxes in the actual budget by ESTIMATES of how much the government would be spending and rec
On-Budget Vs. Off-Budget Surpluses
social security benefits are financed by the payroll tax, social security and a few minor items have traditionally been segregated in the federal fiscal accounts
Off-Budget Items:
- social security expenditures
- the payroll tax receipts that finance soci
Why is the National Debt Considered a Burden
- if the national debt is owned by domestic citizens, future interest payments just transfer funds from one group of Americans to another. However, the portion of the national debt owned by foreigners does constitute a burden on the nation as a whole
- th
Budget Deficits and Inflation
- Suppose the government raises spending or cuts taxes enough to shift the aggregate demand schedule outward from D0D0 to D1D1. Equilibrium changes from point A to point B and the graph shows the price level rise from 100 to 106. Point B represents an inf
The Monetization Issue
If the Federal Reserve takes no countervailing actions, an expansionary fiscal policy that increases the budget deficit will raise real GDP and prices, thereby raising the demand for bank reserves and driving up interest rates (figure 2). if the Fed does
Monetize the Deficit
the central bank is said to "monetize the deficit" when it purchases bonds issued by the government
Debt, Interest Rates, and Crowding Out
A larger national debt may lead a nation to leave less physical capital to future generations. If they inherit less plant and equipment, these generations will be burdened by a smaller productive capacity - a lower potential GDP. By that mechanism, large
Crowding Out
occurs when deficit spending by the government forces private investment spending to contract
- is likely to dominate in the short run, especially when the economy has a great deal of slack
Crowding In
occurs when government spending, by raising real GDP, induces increases in private investment spending
- is likely to dominate in the long run or when the economy is operating near full employment
The Bottom Line
Crowding-Out Controversy (pg. 329)
The Main Burden of the National Debt: Slower Growth
- when government budget deficits take place in a high-employment economy, the crowding-out effect probably dominates. So deficits exact a toll by leaving a smaller capital stock, and hence lower potential GDP, to future generations
- deficits in an econo